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Sept. 9 — The two largest debt buyers in the U.S. must pay $79 million in refunds and fines for allegedly collecting debts through lawsuits and threats in illegal ways, according to the Consumer Financial Protection Bureau.

The CFPB said the practices of Encore Capital Group and Portfolio Recovery Associates violated the Fair Debt Collection Practices Act (FDCPA) and the Dodd-Frank Act. The publicly traded companies were ordered to overhaul their debt collection and litigation practices and to stop reselling debts to third parties. Encore must pay up to $42 million in consumer refunds and a $10 million penalty, and stop collection on more than $125 million worth of debts. Portfolio Recovery Associates must pay $19 million in consumer refunds and an $8 million penalty, and stop collecting on more than $3 million worth of debts.

The bureau has targeted debt collection practices in the past and is working on new rules for the market. Richard Cordray, the CFPB's director, said the agency is working “to clean up the market from both ends.”

Cordray to Industry: Review the Orders

“Our actions today are distinct from that rulemaking, but both are efforts to address certain common problems, such as data integrity, the substantiation of debts, and collection of time-barred debt,” Cordray said in a press call on the actions. “Industry members who sell, buy, and collect debt would be well served by carefully reviewing the terms of these orders.”

Encore is based in San Diego, Calif., and with its subsidiaries, form the largest debt buyer and collector in the U.S. Portfolio Recovery, the nation’s second largest debt buyer and collector, is headquartered in Norfolk, Va., and is a wholly owned subsidiary of PRA Group Inc.

As debt buyers, Encore and Portfolio Recovery purchase delinquent or charged-off accounts for a fraction of the value of the debt, although they may attempt to collect the full amount claimed by the original lender. Together, the two companies have bought the rights to collect more than $200 billion in defaulted consumer debts on credit cards, phone bills, and other accounts, according to the bureau.

Known to be Inaccurate

The CFPB said it found that Encore and Portfolio Recovery tried to collect debts that they knew, or should have known, were inaccurate or could not legally be enforced based on contractual disclaimers, past practices of debt sellers, or consumer disputes.

“Even though Encore and PRA knew that some of the debts they were buying could have substantial problems, they continued to purchase debts from companies without obtaining important documents and information, or checking to make sure that these debts were accurate and enforceable,” Cordray said. “For example, for more than three years Encore bought over 10,000 individual consumer accounts from one large credit card bank with overstated interest rates. Encore then continued to purchase and collect on more debt from this bank even after it became aware that the underlying records were materially inaccurate.”

Robo-signed Court Filings

The CFPB said the companies relied on misleading, robo-signed court filings to churn out lawsuits and sued or threatened to sue consumers past the statute of limitations. In addition, the firms misrepresented their intention to prove debts they sued consumers over, it said.

“Encore and PRA collected debt by suing large numbers of consumers in state courts across the country, knowing that they would win the vast majority of the lawsuits by default when consumers failed to defend themselves,” Cordray said. “For many of these lawsuits, the companies had no intention to prove the debt was valid if consumers contested it, and they made little or no effort to obtain the documents to back up their claims.”

Cordray said the terms of the orders will help improve the approaches “that have become all too common in the troubled debt collection market.”

“We will continue to take action to protect consumers from illegal and obnoxious debt collection practices,” he said.

Impact on Pricing?

The CFPB's action delivers a mixture of new clarity and new uncertainties. In its statement, Encore Capital was critical of the CFPB's approach, saying the action means the agency “intends to drive change through enforcement rather than rulemaking.”

“We continue to firmly believe that a fair and transparent public rulemaking process is the most appropriate method for establishing industry standards,” said Greg Call, Encore's senior vice president and general counsel. “When we ultimately see final industry rules from the CFPB, we expect them to be largely consistent with what is included in this settlement. We appreciate that the CFPB has removed the ambiguity in our industry by providing much-needed clarity around key issues. Now all companies, large and small, should operate on a more level playing field knowing the CFPB's expectations.”

The action may also raise new questions about the pricing and sale of debt in a market still weighing the impact of a May ruling by the U.S. Court of Appeals for the Second Circuit involving Midland Funding and Midland Credit Management—two Encore Capital subsidiaries named in the CFPB's action along with their parent company.

In its May decision, the Second Circuit said Midland Funding cannot claim protection from state-law usury claims under the National Bank Act for loans acquired from a national bank.

Possible Appeal?

Last month, the Second Circuit turned away a petition to rehear the case, positioning the case for a possible appeal to the U.S. Supreme Court and making it one of the banking industry's most-watched disputes.

The ruling itself directly involved nonbank companies, not national banks directly protected by federal preemption. But bankers say the indirect effects are substantial, warning that the case upsets what they say are longstanding expectations that debt buyers may charge and collect interest at rates that were valid at origination. That could make it harder for banks to sell loans, they said.

The Second Circuit's failure to apply the so-called valid-when-made rule has far-reaching significance for a secondary credit market that relies on the rule to enforce credit agreements according to their terms, lawyers at Alston & Bird said in a Sept. 2 memorandum on the Second Circuit case.

“Under the Second Circuit’s decision in Madden, the liquidity and resale value of certain loan assets is uncertain and at risk,” the memo said.

Midland Funding has until early November to file an appeal with the Supreme Court.

After-Tax Charge

Encore trades on the Nasdaq market under the ticker symbol ECPG. The company said it expects to take a one-time, after-tax charge of $43 million in the third quarter of 2015. The president, Kenneth A. Vecchione, said the CFPB scrutinized aspects of Encore's business for more than a year and ultimately identified only two key issues warranting consumer refunds. “While we disagree with the CFPB’s positions on these two issues, we chose to agree to a settlement so we can move forward,” Vecchione said. “We also believe the CFPB is imposing yet-to-be-adopted rules to past practices. This outcome is not about current law or rules already on the books, but instead about the CFPB subjecting companies to its own interpretations that have never been codified or adopted.”

PRA Group, trading under PRAA on the Nasdaq, said that by settling with the CFPB, its subsidiary has negotiated an agreement that “will not materially impact operations and will allow the company to focus on future opportunities without distraction and avoid costly and time-consuming litigation.”

“It was time to end this drawn out process and eliminate the threat of litigation, so we can focus with renewed vigor on serving our customers and growing our business,” Steve Fredrickson, chairman and chief executive officer of PRA Group, said in a Sept. 9 press release. “Given the circumstances, we went the extra mile to achieve closure, despite our objection to the CFPB's characterization of PRA's business practices.”

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